EU-China negotiations on a bilateral investment treaty (BIT) are progressing faster than expected, according to diplomats, even though an increasing number of EU member states are pursuing tighter restrictions on Chinese investment.

Four key issues:

While Brussels’ stance on China is hardening, the EU is likely to remain considerably more open to trade and cooperation with China than the US.

However, the development of stricter EU-level investment regulations will be marred by disagreement among member states vis-à-vis relations with China and remains at risk of being driven by external triggers – particularly US-China tensions.

Worsening US-China relations on trade and technology present some short-term opportunities for European companies, but many retaliatory measures and wider business risks facing US companies in China will also disrupt European firms’ operations there.

The complexity of regulatory and geopolitical challenges for European companies operating in China, as well as the politicisation of China-related business deals, is likely to increase further in the coming two years.

Between China and the US sit opportunities and risks

European capitals, and more urgently European companies doing business in or with China, face an increasingly complex environment. US-China tensions – which are likely to continue in the coming two years even if Washington and Beijing manage to reach a trade agreement – have presented European firms with substantial business opportunities. European suppliers have displaced some Chinese competitors in the US due to tariffs, and in some cases European firms have raised their prices as they supplant previously cheaper Chinese goods. There are even greater gains for European companies selling to Chinese companies, who have either been forced or are choosing to diversify their supply chain away from US companies as a result of rising costs or regulatory restrictions.

However, these short-term benefits are overshadowed by rising long-term risks. European companies doing business with China are likely to face the same political risks and threats of regulatory retaliation that US and Canadian industries are suffering. A more critical European stance towards China makes this more likely in the coming years. Moreover, China sees retaliation against individual European countries or companies as far less costly than retaliation against the US, setting the threshold for potential action against European partners comparatively lower. For now, European companies and politicians are trying to avoid choosing sides, but a further deterioration in US-China relations, and more severe sanctions, might make this impossible.

Reduced EUphoria on China

The EU is pursuing an important transition in its China policy, and several policy statements in the past year indicate that the EU is taking a more critical stance on China. While the EU’s China strategy published in June 2016 used relatively cautious language, a ten-point plan published in March 2019 explicitly describes China as “an economic competitor in pursuit of technological leadership and a systemic rival promoting alternative models of governance”. This change reflects the EU’s rising concerns regarding competition from China, as well as mounting criticism over the lack of reciprocity in access to Chinese markets for European companies. This attitude has also been mirrored in reports calling for greater caution in relations with China published by several member states, including the UK and the Netherlands.

The more negative tone is also affecting European openness to Chinese investment. A peak in high-profile acquisitions by Chinese investors of European companies in 2015 has led several EU countries, including Germany, France and the UK, to move towards reinforcing their regulation of foreign acquisitions. More than 70% of all Chinese FDI into the EU involved state-owned or heavily state-supported Chinese enterprises. The overhaul has resulted in the first blocking of a Chinese transaction in Germany, while other transactions have been delayed.

In March the EU adopted tighter foreign investment screening rules for sectors regarded as relevant for security and public order. The rules’ effectiveness, set to apply from the end of January 2021, will largely depend on the willingness of national-level governments to implement them. However, it is not a robust and comprehensive screening tool. It represents a watered-down compromise that applies only to acquisitions; unlike US reviews of Chinese investment, it leaves out greenfield investment, venture capital or other portfolio investments.

Pragmatism rules

Despite the hardening language and increased scrutiny towards inward investment, the EU is unlikely to politicise the issue of Chinese investment and pursue an antagonistic approach to the degree seen in the US. Although the total value of completed Chinese FDI transactions into Europe – disregarding acquisitions of stakes below 10% – in 2018 fell to EUR 17.3bn from EUR 29.1bn in 2017 and EUR 37bn in 2016, China continues to inject a considerable amount of investment into the EU and they remain major trading partners in goods. It is also worth noting that the drop in Chinese investments into Europe stems from Beijing’s crackdown on outbound Chinese investment it views as dubious, which saw capital controls increase in late 2016.

The EU will likely adopt a mostly pragmatic approach, seeking to generally preserve commercial ties while reducing the persistent trade deficit and – more importantly – limiting its dependency on China. Discussions on adopting new EU-wide competition rules may emerge, though an agreement of the EU28 remains unlikely in the coming year.

Trade of goods: EU imports from and exports to China, 2008-2018

An uneven approach

Geographic location, economic wealth, technological advancement and institutional framework continue to determine the nature of Chinese investment in the EU. Chinese capital investments will remain preponderant in the EU’s largest economies (Germany, France, UK), while the focus will lie on infrastructure development projects in smaller economies.

Disagreement among member states over the approach towards China in the coming years will be driven by national interests and differences in levels of trade, investment inflows and sectors of strategic importance. This will preclude the passing of ambitious EU-wide regulations to limit China’s growing influence that have been advocated by member states that are more sceptical about Chinese investment. Economies driven by innovation and development will continue to seek greater protection, while economies with a greater focus on consumption, foreign capital and tourism will regard Chinese investment more as an opportunity than a threat.

Despite a scolding from the EU, several member states – including Greece, Italy and Portugal, which have been particularly impacted by financial and economic crises in the past decade – have signed up to participate in China’s Belt and Road Initiative (BRI). Six western Balkan countries – which are not EU member states – are likely to remain most welcoming to Chinese investment, given the poor state of transport infrastructure and energy facilities in the region compared with the rest of the EU, and the lack of sufficient domestic and European funds to upgrade them.

EU-China trade in 2018

China wants Europe on board and on message

China continues to see Europe as an important source of political and economic capital to ease the external pressures of US-China disputes. Slowing economic growth has been exacerbated by US tariffs and efforts by US President Donald Trump’s administration to ban certain Chinese companies from access to US markets or technology over alleged national security concerns. European countries, and the EU as a trading bloc, present an opportunity to offset some of the economic impact.

Equally importantly, cooperation with European partners on issues ranging from climate change, to WTO reform, to BRI offers China political backing to counter what it perceives to be a Washington-led narrative to undermine Beijing’s rising global political influence. While Beijing considers European participation on BRI important to shore up the initiative’s credibility, it most prizes continued cooperation on technological exchanges at a time when US measures could pose an existential threat to leading Chinese companies.

The politicisation of China-linked business deals will continue to rise, regardless of whether Beijing uses carrots or sticks to encourage European alignment with Chinese priorities. In support of bilateral ties, China is speeding up improvements on market access, including through negotiations on the BIT, which will now see monthly meetings taking place to ensure progress by year’s end. However, Chinese authorities have also put European firms under considerable pressure, explicitly warning them to resist siding with US policies on China. European companies are also vulnerable to being put on a new “unreliables list” that will designate companies with major compliance violations or that fail to meet their obligations to Chinese partners due to political reasons.